HC1494 Work & Pensions CommitteeWritten evidence submitted by the National Employment Savings Trust (NEST)

Introduction

NEST is a low-cost occupational pension scheme that provides a straightforward way for employers to meet the new duties that begin to be introduced from 2012. The scheme is run by NEST Corporation which has a number of legal duties, one of which is to act in the interests of its members. NEST Corporation has a public service obligation to accept any employer that wishes to use NEST to meet their new legal duties.

NEST is designed for a target market of UK workers that are largely new to pension saving. Many of these workers will be automatically enrolled by their employers into a qualifying pension scheme once the new duties begin to impact employers.

The existence of NEST and many of its features are key elements of the political, pensions industry, employer and consumer consensus on workplace pension reforms.

NEST Corporation is accountable to Parliament through the Secretary of State for Work and Pensions. It is therefore not NEST Corporation’s position to comment in general on Government pension policy.

The purpose of our submission is to supply the committee with such evidence as we can to support them in their deliberations of the policy framework around NEST and NEST’s role in delivering the Government’s broader workplace pension reforms.

Likely Impact of Automatic Enrolment on Small Businesses and Start-ups

Government has considered in some detail the extent of the regulatory burdens of automatic enrolment on businesses. The scheme is therefore designed so that an employer using it to meet its legal requirements will find NEST easy to use. Reducing employer burdens through simple processes is a key role of NEST.

To this end NEST has fully engaged with the Federation of Small Businesses, the Confederation of British Industry, the British Chambers of Commerce and other business organisations as well as researching employers of all sizes when testing the product. NEST has recently announced appointees to its ‘Employer Panel’, including representatives of key employer representative bodies and individual employers, putting employers at the core of our governance.

NEST is likely to be used by employers of all sizes. Specifically relating to smaller employers, the scheme has been designed to be suitable for employers that are not large enough to have their own human resources function.

Key features that make NEST suitable for small employers include:

easy to use online set-up and administration;

clear communications; and

no ongoing administration when a member leaves their employment.

Online set-up and administration

Before workers can join NEST, employers must provide us with some information about their organisation, workers and how they will use the scheme. Setting up is similar to signing up to an online shopping account, after which the employer then enters certain details about when they plan to pay contributions and how much they will pay on behalf of their workers.

Employers can submit this information by entering it manually, or by uploading a file either via our secure web environment or, for larger businesses, using an industry standard secure file transfer protocol. Smaller firms are likely to enter data manually. For a firm employing 10 people, set-up time is likely to be as little as one hour. Ongoing administration time depends on the scale of required changes from previous months, for example, entering new workers. If no changes are required, the administration process is likely to take only minutes.

Making contributions

Processing contributions is likely to be the task employers perform most regularly. NEST’s systems have been designed to make this process straightforward. Employers need to prepare their contribution schedule by setting out the contributions made in the pay period they choose to use. This period could be weekly, every four weeks or every calendar month.

There is flexibility in levels of contributions, grouping of individuals, and in payment periods. Payment can generally be made by Direct Debit, Direct Credit or debit card. These payment methods are highly innovative amongst pension products.

Smaller employers do not need to complete any software-related upgrades or processes.

Employers can easily delegate others to manage their accounts, such as a colleague in HR or payroll. They can also choose to delegate to someone from outside their organisation, such as an accountant, financial adviser or payroll provider.

Clear communications

NEST Corporation uses clear and easy-to-understand words and terms. This is important for employers of all sizes but especially for small employers and start-ups that may not have access to professional advice.

Extensive research has helped us understand how our members and their employers would like us to provide information. Our research tells us that existing pension terms can be a barrier to understanding and participation. We have developed and published a NEST phrasebook of terms which have been tested and are appropriate for our audiences.

This approach should mean employers are less likely to face questions from their workers about pension saving and will find NEST easy to use.

Administering ex-workers’ retirement pots

Another important aspect of NEST is that our members have one retirement pot that they keep whether they change employment, stop working or become self-employed.

This means that they can continue to pay into their pot as they move from job to job and that more than one employer can contribute to their pot at the same time.

Because of this, there is no ongoing administration for employers if someone leaves their organisation.

Generally, there is no charge to employers for day-to-day services and NEST’s low member charges mean more value for money on contributions from employers and workers.

NEST Market Share and Effects on Providers

Our evidence on how employers are planning to use NEST and how employee benefit consultants (EBCs) are planning to recommend using NEST, suggests that NEST will consistently be used to complement existing employer workplace pension provision.

How NEST can be used

Employers can use NEST in a number of ways, including for example:

as a sole scheme for all the workers in an organisation, for example if there is no current pension provision in place;

for a particular group of workers alongside an existing scheme already in place for a different category of workers;

as an entry-level scheme where there is an existing scheme that has a waiting period; and

as a base scheme to ensure compliance with the new employer duties, using another scheme to pay in additional contributions.

Joint propositions with existing providers

NEST Corporation is working with a number of providers where NEST may be more suited to some of their clients’ workers than their own existing offer. We are working with these providers to develop joint propositions where NEST will take workers who are not economically viable to its partner provider. The existing provider can then either maintain existing provision or expand into the automatic enrolment market where it is viable for them to do so with NEST taking on NEST’s target market.

There are a number of ways that NEST can be used alongside another provider or providers within a single employer. For example, different schemes could be offered to different categories of worker, such as head office and shop-floor staff or hourly paid staff and salaried staff.

Alternatively, NEST could be used as an entry-level scheme, where workers in an initial period of employment are enrolled into NEST and then move onto the main company scheme. This helps providers to deal with the administration challenges and costs created by high early-years staff turnover in some firms.

In these ways NEST is of significant potential benefit to other providers as they consider how to shape their own responses to the onset of the new duties on employers and how those duties will affect their existing and future clients.

Market share

In 2012 we estimate that there will be around 19–20 million private sector workers ^[2]

Around 9–10 million private sector workers are not participating in a qualifying scheme and are eligible for automatic enrolment,1 and are therefore the focus of the reforms. This is around 50% of all private sector workers. Anyone within this group can be automatically enrolled into NEST if their employer chooses the scheme, but within this group NEST is being developed for a specific audience of workers. These workers are those who are likely to have had no access to a workplace pension scheme before. They number around eight million people, or 40% of all private sector workers.

We do not have accurate data on how many workers will actually join the scheme. This will be dependent on which scheme employers choose, which workers they enrol into the scheme and whether workers who are enrolled in the scheme choose to opt-out.

Based on our analysis, which uses a number of assumptions, and taking into account staging, we estimate that NEST could have around two to five million members by 2016. This amounts to around 10–25% of all those employed in the private sector, the total market potential, and around 22–50% of all eligible private sector workers currently without access to a workplace pension scheme.

Opt-out Rates and Possible Impact on NEST

The Government estimates that the number of contributing members of NEST at the end of automatic enrolment staging will be between two and five million. NEST Corporation would still be able to achieve the long-term aim to for the scheme to be self-financing through member charges anywhere in this range, but obviously it would take longer with fewer members.

A lower level of volume than this would create an ongoing funding challenge around the scheme and would therefore be a challenge to the policy in its own right. But if volumes fell below this level, this would represent an outcome significantly at odds with the Government estimates of the expected outcomes of the policy.

At least some possible causes of this outcome—for example very high opt-out or non-compliance—would also in their own right represent challenges in respect of the policy. They would therefore prompt a much broader set of questions for the Government than those relating simply to NEST’s viability.

Specifically in relation to opt-out, we estimate that opt-out would need to considerably exceed 50% of those automatically enrolled before NEST’s viability was called into question on the basis of opt-out alone. This is a level far above where evidence suggests opt-out will actually be, even on the most pessimistic assumptions.

Automatic re-enrolment would also play a significant part in reducing the long-term impact if initial opt-out were higher than expected.

Likely Impact of Limitations on NEST through Contribution Cap and Transfer Restrictions

NEST was established to correct a gap in the supply of low-cost pension savings vehicles to workers with lower earnings and/or those who change jobs more frequently. These people had traditionally not been served by the existing pensions industry.

An important consideration in establishing NEST was how to ensure it remained focused on this market and did not cut across those areas where existing supply was working effectively. The contribution cap and ban on transfers were policies intended to help with this consideration.

The challenge of ensuring NEST remains focused on the market it was established to serve remains a core consideration in the maintenance of the broad political and stakeholder consensus that has been important to the successful progress of this agenda to date. NEST supports the maintenance of that consensus.

The evidence given in the remainder of this section should be seen in this light. It seeks to highlight that the specific approaches of a contribution cap and a transfer ban to delivering this outcome raise some challenges around implementation. In turn these create additional costs and complexity for our members and participating employers.

The weight given to these considerations, and whether alternative mechanisms might be available that deliver the same positive outcomes without some of those implementation challenges, remain matters for Government. Some of these questions, including specifically around the contribution cap, have already been addressed relatively recently in the Making Automatic Enrolment Work review which reported to Government last October.

The contribution cap

In seeking to implement the contribution cap we have encountered two broad challenges:

Impact on employer decisions:

The presence of a cap on contributions to NEST that is below the annual allowance which applies to all schemes of £50,000 is a feature that is unique to NEST. It is therefore an unusual consideration for employers in terms of their choice of provider(s).

In its own right, this novelty is not necessarily a cause for concern. However there is some evidence in the feedback that we receive from employers that the existence of the cap creates some difficulty for them in deciding how to respond to the new duties.

In particular, an employer who has identified a strong fit between the needs of their workers and NEST but who has some workers whose contributions would exceed the cap is faced with the choices to:

make lower contributions for some workers;

choose an alternative scheme for all workers; and

adopt multiple schemes.

Market feedback is that generally employers—especially smaller ones—would like to have one provider, suggesting that this challenge will often result in one of the first two approaches.

These issues should be considered in the light of the balance that the Government sought to strike in originally putting the cap in place. That balance was between focussing NEST on its target market while allowing some scope for employers and workers to contribute more than the statutory minimum of 8% of band earnings.

The trade-off between earnings and contribution levels and the interaction with the cap is illustrated in the table below. This is which is based on contributions on gross earnings, rather than the band of earnings used to define the statutory minimum contribution.

Finally, some further complexity may also arise from the interaction between NEST’s contribution cap and the planned certification approach currently before parliament. This approach allows employers to certify satisfaction of the quality requirement on the basis of different contribution percentage levels and definitions of earnings.

The policy intent behind allowing certification was to aid good existing schemes, but the option is nonetheless there for new schemes as well. For employers choosing to use this option, some workers may receive ‘minimum contributions’ that exceed NEST’s contribution cap. The certification requirements are still being finalised but this is potentially a complex issue to communicate to employers and could exacerbate the issues described above.

The administrative and operational impact and associated costs of the contribution cap on NEST

In cases where the contribution cap is exceeded there are complex difficulties in identifying which contributions fall within and outside the cap. There are also subsequent complex calculations relating to refunds and tax relief.

In cases where a NEST member has multiple employers, we expect it to be more likely that annual contributions will exceed the cap. Managing this where it occurs requires the use of manual processes which are costly to administer.

Transfer restrictions

As with the cap there is an element of novelty about the restrictions on transfers. These are generally allowed between most other pension schemes—and this may on occasion complicate the choices faced by employers, although fewer employers raise this directly with us as a concern.

Perhaps more of a challenge is raised by the potential issues that the transfer restrictions create for pension savers who move to an employer offering NEST and are unable to consolidate their previous savings with their new one. Possible issues are:

Where a previous scheme has higher charges than NEST, the member is unable to transfer in their savings to benefit from the lower charges. If they move on to another scheme after NEST they are unable to take their NEST savings with them to that scheme as well.

There is some evidence of schemes differentiating between the charges on active members and those who have stopped contributing, known as active member discounts. If schemes charging on this basis were to become common, the problem of savers leaving money behind in higher charging schemes may become more acute.

That savers build up more individual (increasingly DC) pension pots through their working life, making the conversion of savings into a retirement income more complicated when they come to take their money out.

Finally, there are consequences for existing schemes of the restrictions on transfers into NEST. Automatic enrolment means there are likely to be more small dormant pots that are expensive to administer. Solutions to this problem where NEST plays a role in accepting transfers of small pots may exist that would not require a complete abolition of the restriction on transfers in to and out of NEST.

NEST’s Investment Strategy

Built on an understanding of our members

NEST has thoroughly considered research into the characteristics, circumstances and attitudes of NEST’s target market. Our investment strategy is designed for NEST members.

Our research shows that NEST’s membership, with likely median earnings of around £20,000 is likely to be less able to absorb financial loss than those currently saving in a workplace pension scheme with median earnings of around £30,000. They are also likely to be less comfortable with investment risk and unlikely to recognise the long-term risks of inflation.

Our research suggests that younger members are particularly sensitive to volatility and loss. NEST’s membership will be diverse and their appetites and capacity for risk will vary over time.

Some of our members may wish to invest according to their faith or beliefs.

NEST’s investment approach

NEST’s investment approach combines the reassurance of a carefully-managed investment for the majority who don’t want to choose, with a set of focused choices for members who do.

For those who don’t want to choose, their money will be invested in one of our NEST Retirement Date Funds.

There are more than 40 individual NEST Retirement Date Funds—one for each year a member could choose to take their money out.

Each fund is managed and invested to take the appropriate risk for the year the member plans to retire.

For those who want to chose, the following additional funds are available:

NEST Ethical Fund;

NEST Sharia Fund;

NEST Higher Risk Fund;

NEST Lower Growth Fund; and

NEST Pre-retirement Fund.

We expect the majority of members to be invested in the NEST Retirement Date Fund appropriate to their expected retirement year.

How NEST Retirement Date Funds work

NEST’s Retirement Date Funds will take different amounts of risk at different stages in a member’s saving career, known as the Foundation, Growth and Consolidation phases.

Foundation phase

Member research shows that people aged 29 and below have a lower risk capacity and are more likely to react negatively to volatility and loss. This means it is appropriate to have a lower risk strategy as they get used to saving.

We know from our member research that the vast majority of younger members in the scheme are unlikely to have saved in a pension scheme before and will have little experience of investment risk or market volatility.

The Foundation phase is designed to reduce volatility in the early years while the savings habit is being developed. The objective is to match CPI after charges.

Growth phase

In the Growth phase we will be looking to maximise the value of the retirement pot, within our risk budget. The objective is CPI + 3%. Through investment in a higher proportion of return seeking assets the member will be able to participate and benefit from economic growth around the world.

For example, we will be investing in both developed and emerging markets—in equities, corporate bonds and property, all of which benefit from economic growth.

Consolidation phase

The Consolidation phase is about preparing the member’s retirement pot for the year they plan to take their money out.

It is a method of realising (banking) the growth that has been accumulated over the savings career while avoiding significant losses late in the journey, when there is no time to recover. The objective is to manage the conversion risk—this is about achieving a smooth and effective switch from growth assets into retirement assets. This could be cash and/or a retirement income although NEST’s Retirement Date Funds maturing in the early years will be more likely to be taken as a cash lump sum.

In the Consolidation phase money is gradually taken out of return-seeking assets, such as equities. It will be put into assets that are likely to be less volatile and more appropriate to what the member will do with their money when they take it out of NEST.

Other fund choices

NEST’s Ethical Fund will have similar investment objectives to NEST Retirement Date Funds but will only invest in companies that meet certain ethical criteria, as well as gilts and the underlying liquidity fund.

NEST’s Sharia Fund will only invest in companies that are compliant with Sharia principles.

NEST’s Higher Risk Fund will take more investment risk and aims to deliver a higher return. We aim to achieve this by investing in equities as well as a diversified basket of other assets which tend to offer higher returns.

NEST’s Lower Growth Fund will take very little investment risk but stands a greater chance of not protecting against inflation over the long term.

NEST’s Pre-retirement Fund is for members who, in the early years of the scheme, may want to buy a retirement income with their pot rather than target a cash lump sum.

Treatment of Self-Employed, Part-time, Temporary, Casual and Agency Staff in Automatic Enrolment

Many part-time, temporary, casual and agency staff will be in NEST’s target market. Some features of NEST are particularly attractive for this market:

NEST travels with the member;

NEST is a low-charge scheme; and

NEST is flexible and has no inactive member penalty.

Travelling with the member

NEST is a retirement pot for life. Members can take NEST with them between jobs where the employers offer NEST. This also means that members can start and stop contributions as they come in and out of work.

Low charge

Low charges equivalent to NEST’s have been difficult to attain for these groups elsewhere in the market. NEST’s low-charges for all members are broadly equivalent to a 0.5% AMC over the lifetime of saving. That means NEST members, including those who are self-employed, use less money on charges and can put more towards their income in retirement.

NEST is flexible and has no inactive member penalty

Self-employed, temporary and casual staff could easily increase their contributions when times are good and, if they have cash flow problems, reduce or stop making contributions for as long as they need to. Unlike many other pension schemes NEST will not have higher charges for inactive members than for contributing ones.

With NEST, self-employed people can set their own contribution rates within our total annual limit which is currently set at £4,200.

We will provide self-employed people with guidance about NEST that’s specifically tailored to their needs.

12 September 2011